Dr. Inequality--Bush's new economist has a curious prescription.
<a href=slate.msn.com>slate.msn.com By Daniel Gross Posted Friday, May 23, 2003, at 3:15 PM PT
Last week, Kristin J. Forbes, a young Massachusetts Institute of Technology economist, was named to President Bush's Council of Economic Advisers. Professor Forbes has an impressive résumé, but one can't help but think that one article in particular helped put her over the top.
In her most prominent journal article, which appeared in the American Economic Review in 2000, Forbes concluded that "in the short and medium term, an increase in a country's level of income inequality has a significant positive relationship with subsequent economic growth." In other words, after employing various forms of regression analysis and crunching scads of data, Forbes presciently affirmed what President Bush and the Republicans who control Congress have long implied but never said: If you want to put a jolt into the economy, fix fiscal policy so that it widens the gap between rich and poor. By reducing marginal rates and cutting taxes on dividends, that's precisely what the most recent gimmick-laden tax bill will likely do.
But Forbes—who appears to be no relation to the better-known Forbes family of income inequality advocates—is an academic economist, not a think-tank jockey. Her argument, although easily caricatured, has less to do with partisan politics and more to do with an ongoing academic debate about the relationship between economic inequality and growth.
In the middle part of the 20th century, the prevailing presumption was that income inequality was good for growth. Putting more money in the hands of the rich, who saved more, would provide economies with the means to finance investment. Under the schemas of influential economists such as Keynes contemporary Nicholas Kaldor and Nobel Memorial Prize-winner Simon Kuznets, governments faced a tough choice in devising fiscal policy. They could either spread income out more evenly, which would harm growth, or stimulate greater growth by fostering greater inequality.
In recent decades, the accumulated knowledge about how economies performed in the post-World War II era started to undermine this view. Countries in East Asia—Japan, Korea, Singapore, etc.—charted impressive growth over long periods, even as the distribution of wealth remained relatively equal. And regions in which income inequality was both massive and stubbornly persistent—i.e., Africa and Latin America—were perennial laggards. Indeed, the very structures that calcified income inequality—dynastic landholding, corrupt governments, lack of investment in public education—seemed to militate against growth.
In the 1990s, a wave of empirical research found that, in fact, countries with high inequality over a long period of time have low growth. This paper by Harvard professors Alberto Alesina and Dani Rodrik is a good example of such work. When there's a lot of inequality, the median voter will be poor. As a result, populist backlash will pressure the government to enact redistributionist policies and tax capital, thus hurting investment and stunting growth. (See under: Venezuela.)
Forbes' article uses new data and different methodology to poke (tentatively) at this conventional wisdom. Alesina and Rodrik—and many other researchers in the 1990s—took a "cross-country" approach, examining the relative economic performances of high- and low-inequality countries over time. But Forbes chose instead to look at the performances of individual countries over time and investigate whether there was a correlation between periods of higher or lower inequality on the one hand and periods of higher or lower growth on the other. Of course, it's possible that the relationship she detects between growth and higher inequality is more coincidental than causal. As New York University economist Bill Easterly put it: "It's more likely that what she was finding was that there are long waves or business cycle waves—maybe during booms, inequality rises, and during recessions, inequality falls."
Forbes—whose dissertation committee included the avowedly anti-Bush economist Paul Krugman—says she isn't certain about the meaning of her results. She notes that "the relationship is far from resolved" and that it is "too soon" to reach "any definitive policy conclusions." Unfortunately, the Bush administration and its Republican allies suffer no such compunctions.
Daniel Gross (www.danielgross.net) writes Slate's "Moneybox" column. You can e-mail him at moneybox@slate.com
Bush's new economist has a curious prescription.
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Remarks from the Fray: …In Dr. Forbes' article, she writes that "it is possible that the strong positive relationship between inequality and growth could diminish (or even reverse) over significantly longer periods [than 10 years]." It's worth noting that income inequality in the U.S. has been increasing (as I recall) for significantly longer than the 10 year threshold that Dr. Forbes identified. As a noneconomist, might I ask if it would be consistent with Dr. Forbes' article for the U.S. economy to be presently slumping because we have had a prolonged correlation between inequality and growth, leading to the diminution or reversal of the relationship between growth and inequality that she could not rule out? At the very least, looking at the conclusion of her article, it seems that Dr. Forbes recognizes that absolute income inequality is not an absolute good. If only there were some sign that the Bush people are aware of that as well. --Dameffy
…Kuznets did NOT describe inequality as a cause of growth but as a temporary consequence of economic growth. As rapid growth begins, lead sectors take off, and the income of capitalists (and even some workers) in those sectors grows faster than other incomes; hence inequality grows. As growth balances (lots of reasons and possibilities), the income distribution becomes more equal. So the "Kuznets Curve" describes an inverted-U relationship between growth (cause) and inequality (effect). After an economy reaches some threshold income--low enough that the advanced industrial countries had passed it by the early part of the 20th century--rising tide raises all boats. Kuznets did not think that inequality causes growth, he did not assert a policy trade-off between equality and growth trade-off, nor did he advocate inequality. In summary, Kuznets held that growth at first increases inequality and then decreases it… --M-westernmass
…This is a particularly tricky debate because it crystallizes what I think of as the four main groups in American Politics: Liberals, conservatives, libertarians and authoritarians. Liberals and authoritarians form one group for financial matters with conservatives and libertarians on the other side….Ultimately, freedom demands of us that we go out and provide goods and services for others which they value in order to survive. We all go out, work and are rewarded according to how well we judge and satisfy the desires and appetites of others. A person is only as valuable as he or she is difficult to replace. I spend my resources (time, money and attention) attempting to secure for myself the best living I can. Doing so involves providing goods and services to others. My employer values one hour of my time more than a certain wage and I value that wage more than the hour of my time….With a system of redistribution in place, the transfer beneficiaries do not have to work as hard as before to attain their previous material status. Additionally, the precedent has been set that one may simply vote for a better standard of living instead of having to go out and take the thousands of tedious actions necessary to achieve that standard on their own. Further, dependency breeds resentment. Class warfare flourishes, bogeymen are continually set up and knocked down, profit goes from being the best beacon of doing something right for others to being a dirty word, victimhood loses its stigma and becomes a profession, and children are raised with few of the skills necessary to fend for themselves without increasingly massive handouts. Every direct transfer program, environmental standard, OSHA regulation and labor law that we have exists only because certain people (rich or poor) were uncomfortable with the strength of their positions in relationships with others and decided to diminish the power of parties they perceived to be adverse by limiting their freedom. The rich have now poked out the eye of the poor and vice versa and none of us is better for it. Redistribution in either direction retards individuality, kills dignity, discourages productive behavior, encourages further theft and kills freedom. --NickPasse
I am no fan of the policies of the Bush administration, nor a believer in its good motives in general (sample my other posts if you don't believe me). But I have to disagree with Daniel Gross's theory that Dubya is stuffing his Council of Economic Advisors with intellectual defenders of his policies. Kristin Forbes does look like an odd appointment at first glance. She is only five years out of graduate school, and has a single publication in a blue-ribbon economics journal. However, she already has good policy experience, including a stint as assistant Deputy Secretary at Treasury last year (and earlier experience at the World Bank). It seems more like an internal promotion than a fresh appointment to me. More importantly, look at some of the other appointments. The nominee as Chairman is Greg Mankiw, an adherent of the New Keynesian school of macroeconomics, which is a rival of the Chicago school in its advocacy of pro-active macro-management and government interventions in the economy. The same can be said of another appointee, Harvey Rosen of Princeton. If Bush wanted well-credentialed conservative economists, there are much better choices: Bob Lucas (Chicago), Tom Sargent (NYU), Robert Barro (Harvard), to name a few. (Here [post.economics.harvard.edu] is a sample of Mankiw's views on monetary policy. But wait, in this [post.economics.harvard.edu] one, he argues that social security funds should be invested in the stock market; read the abstract. Hmmm...!!) So I think Gross is a little off the mark. Isn't the Council of Economic Advisors a somewhat ceremonial body, anyway? The real policy making power lies with the Treasury. And, surprise surprise, you will find only ex-CEOs there. --Sissyfuss1
…Bush has just moved his CEA team two blocks further away from the White House, a detail that in Washington terms means a serious reduction in rank. Our of sight, out of mind, Bush may now proceed with screwing up the biggest economy in the world without pesky details rubbing up against his shoddy work. In the mean time, the mainstream economic community has spoken: In a recent joint statement, 10 Nobel laureates in economics and 450 other economists said there is wide agreement that the purpose of President Bush's tax plan is permanent change in the tax structure and not the creation of jobs and growth in the near-term. The permanent dividend tax cut, in particular, is not credible as "short-term stimulus." Job losses are currently occurring at a 1.5 million per year clip, showing that the long neglected economy now needs a direct and immediate stimulus. Bush claims that GDP growth will be highest in the first two years (it has to, because GDP is now an unsustainable negative). This implies that they will decline in 2005, 2006 and 2007 relative to what we would expect if no plan were implemented. Other forecasters have reached similar conclusions. An analysis by Mark Zandi, president of Economy.com and definitely not a liberal, shows a positive impact over the first two years (a dismal 0.8 percent higher GDP over two years) but an annual GDP decline of 0.25 percent thereafter. Consequently, GDP is lower by 1.0 percent in 2013 than it would be with no Bush package. The result is a loss of 750,000 jobs by 2013. We pay for that by bankrupting the Treasury, billing our children, delivering decidedly less public services, and increasing tax unfairness, radically increasing poverty in America. --GaryWmoderate